Canada has unfinished business when it comes to preparing for the next big financial crisis.
Canada has unfinished business when it comes to preparing for the next big financial crisis. Certainly, our financial system held up comparatively well in the 2008 crisis, and lots has been done, but we have shortcomings still to address.
When the International Monetary Fund last reviewed Canada's financial system in 2014, it recommended we do better in managing federal-provincial co-ordination around systemic risk oversight, and improve systemic risk management in capital markets. The IMF will return soon for an update assessment. So the question is, how are we doing?
As argued in a recent C.D. Howe Institute paper, Canadians should expect a higher level of preparedness from all relevant federal and provincial authorities. Then, problems arising in one part of the financial system would not cause ripple effects endangering the system as a whole – which is really what systemic risk is all about.
Just because we did well last time is no reason to not want even better preparation, giving us confidence we will be successful next time as well.
But there is very little clarity and transparency about how the new system will work in practice. Transparency about how the authority will analyze systemic capital-markets risk, and the framework it will use to react, is itself a useful tool to guide private economic agents who of necessity don't have the full system-wide view. For the new authority to make a meaningful contribution to systemic risk oversight it needs to:
Develop and publish the framework it intends to use to analyze systemic risk in capital markets;
Commit to regularly publishing its analysis of systemic capital market risk;
Ensure authority is given to a senior person in the regulatory authority with a clear mandate for systemic risk work;
And play a lead role in arranging sharing of all market data necessary for financial-stability analysis, which is now managed in silos.
What other issues are still at play? Several years ago, the Bank of Canada clarified that major systemically important financial institutions such as the Quebec-based Desjardins system and the B.C. Credit Union Central will only be eligible for Bank of Canada emergency liquidity assistance in a crisis if prearrangements are in place with provinces to cover any losses. But important provinces have not made progress in entering into necessary arrangements with the Bank of Canada. Those entities are important because of their position in their respective provinces and because they also link into the national financial system. The start of a crisis is not the time to try to negotiate these arrangements.
The authorities have also not been clear about how federal-provincial co-ordination relative to potentially systemic issues is supposed to work. Building trust is essential to being able to manage effectively in a crisis. In our federation, it is not necessary or desirable to give one organization overall responsibility – that would exacerbate friction. But adding clarity about responsibility and accountability in existing ad hoc federal-provincial co-ordination mechanisms for crisis management would focus minds, help build trust and clarify accountability and promote co-operation.
As well, certain provinces have not adequately addressed weaknesses in the safety-and-soundness regulation of deposit-taking institutions such as provincial credit unions. Analysis is hampered because of a lack of transparency by a number of provinces in their regulation and supervision of financial institutions, including those they have designated as systemically important. They should be more transparent.
While it appears that Quebec has been active in upgrading regulation and supervision, there are signs that British Columbia and Alberta have been slow to respond to issues they themselves identified in their own review of their regulatory framework, or that provincial auditors-general identified. They should ensure their frameworks of regulation are up to date and resourcing is adequate.
None of this has to be an overwhelming, expensive task – and the effort and resources expended in advance are worth the savings in avoiding the next potential crisis.
Nicholas Le Pan is a Senior Fellow of the C.D. Howe Institute and former Superintendent of Financial Institutions, Canada.
Published in the Globe and Mail.